Canada: Spring Loading Recognized As An Offence Under The QSA In Québec

On August 9, 2016, the Tribunal administratif des marchés financiers (the "Tribunal") formerly known as the Bureau de décision et de révision en valeurs mobilières (or BDRVM), rendered a two-part decision, the second part of which involved what is known as "spring loading", now recognized as an offence under the Québec Securities Act1. The case involves accusations of tipping and insider trading in connection with a verbal offer by Open Text Corporation ("Open Text") to acquire Nstein Technologies Inc. ("Nstein") at a time when Nstein was seeking to be bought out. This is the first Quebec decision dealing with "spring loading", an offence that finds its origin in U.S. case law.

The first part of the decision deals with Pierre Légaré, the accountant of the chief executive officer of Nstein, Luc Filiatreault, who was accused of tipping. After having been informed by Mr. Filiatreault of Open Text's offer to acquire Nstein, Légaré traded on Nstein's shares while in possession of allegedly privileged information, making a profit of $15,765. An agreement was reached between the regulator, the Autorité des marchés financiers (the "AMF") and Mr. Légaré whereby he agreed to pay an administrative penalty of $23,500, representing 150% of the profit he made trading on Nstein's shares. Considering, inter alia, his transparency and the remorse he showed, the TAMF approved the administrative penalty under the agreement.

The second part of the decision concerns accusations against the members of Nstein's board of directors and some of its senior officers for having adopted a resolution authorizing the corporation to issue 1,200,000 options to purchase its shares at a time when those individuals were in possession of allegedly privileged information regarding the potential acquisition of Nstein by Open Text. The directors and senior managers involved were thus accused of "spring loading"2 by the AMF:

[72] This was essentially a financial stratagem initiated by senior management of a reporting issuer who were in possession of privileged information, which consisted of issuing options to purchase shares of the issuer at their market price, knowing full well that the price of those shares was likely to increase substantially in the near future, when the privileged information became publicly known.3

Open Text's verbal offer to acquire Nstein was made in November 2009 by Open Text's chief executive to Mr. Filiatreault, who then informed Nstein's board of directors of it. The corporation gave serious consideration to the offer and took steps to further it. A few weeks later, in January 2010, the members of the board, including Mr. Filiatreault, signed a resolution authorizing Nstein to issue 1,200,000 options to purchase shares of the corporation, at a time when they were in possession of alleged privileged information, and when a prohibition on trading in the corporation's shares (a "blackout" period) was in effect for all insiders and employees of the corporation. Some of Nstein's senior officers also accepted such options at a time when they were in possession of the alleged privileged information.

The directors and officers of Nstein targeted by the accusations of the AMF argued first of all that they had not in fact traded on any of Nstein's securities. In the alternative, they pleaded various grounds of defence, including the following:

  1. the granting of the options was not done by Nstein's board of directors, but by the corporation itself, as a legal person, thereby giving the respondents the protection of the corporate veil;
  2. the decision to grant the options preceded any discussions with Open Text;
  3. in the alternative, the grant of the options was "necessary" in the course of Nstein's business, within the meaning of paragraph 2 of section 187 of the Securities Act;
  4. they were not in possession of any privileged information as defined in section 5 of the Securities Act, and
  5. they received no benefit, pecuniary or otherwise, as a result of the granting of the options.

In its analysis the TAMF pointed out that "the spirit and the letter of the Securities Act enshrines the fundamental principle of the equality of all investors in terms of the possession of information when engaging in trades in the securities of reporting issuers"4.

The TAMF rejected all of the grounds raised by the directors and officers of Nstein in their defence. With respect to the argument that the granting of the options was "necessary" in the course of Nstein's business, within the meaning of paragraph 2 of section 187 of the Securities Act, the TAMF stated the following:

[118] The Tribunal is of the view that if it were to characterize such an operation as "necessary in the course of business" of a reporting issuer, it would be opening the door to a potential multitude of similar stratagems whose deleterious effects would circumvent the application of an obligation under the Securities Act that constitutes the very basis of the equitable regime put in place by the legislature governing the use of information. The consequences of such a decision would, in the Tribunal's view, be nothing short of disastrous, and the Tribunal is accordingly not prepared to go down that road.5

According to the TAMF, in light of the serious nature of the offences committed by the directors and senior officers of Nstein, the strategic management positions they held during the period covered by the accusations, and their lack of remorse, the TAMF took the view that "it is essential to take appropriate measures to protect the investing public and to ensure the integrity of the markets6. The TAMF accordingly imposed, as a dissuasive measure, an administrative penalty of $180,000 for Luc Filiatreault the CEO of Nstein, of $72,000 and $36,000 for the two other Nstein officers involved, $30,000 for the chair of Nstein's board of directors, and $20,000 for the remaining directors.

Take Away – This decision is interesting as it is the first in Québec to recognize the offence of spring loading. By doing so, the TAMF went through a thorough analysis of the policy underlying insider trading and tipping offences under the QSA. The board of public companies must be aware of this decision and of the principles underlying same to make sure that adequate internal controls and policies are in place to avoid such unfortunate situations.


1 Autorité des marchés financiers v. Filiatreault, 2016 QCTMF 8

2 It should be noted that in U.S. case law "spring loading" has a counterpart known as "bullet dodging", a term used where the granting of stock options is delayed until unfavourable news concerning the issuer is made public, thereby causing the price of its shares to drop.

3 Supra, note 1, at par. 72 [TRANSLATION]

4 Ibid, at par. 73 [TRANSLATION]

5 Ibid, at par. 118 [TRANSLATION]

6 Ibid, at par. 125 [TRANSLATION]

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Jessica Syms
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